Investment banking fees survey: The waiting game

A disastrous run for equities has taken its toll on overall investment banking fees so far this year. Bankers are holding out for a pick up in the final quarter – market conditions permitting

By Ben Miller

It’s not over till it’s over. But
so far, 2012 has proved mildly disappointing for investment
banking fees: revenues from equities are down in line with the
markets although debt income is holding steady and M&A is
on the up.

What happens in September, in particular, will spell out the
larger picture for fees this year. Bankers are hoping that an
uptick in debt issuance, similar to that seen in the first
quarter, will boost DCM revenues.

So far this year, overall fee income appears largely
unchanged, with differences in revenues driven almost entirely
by the volumes of transactions in each bank’s
different business lines. At $1.03 billion through August 17,
the total is down versus the $1.35 billion in the corresponding
period in 2011 – but not so much as to make catching
last year difficult.

"The only fee base that came down was ECM," says Guilherme
Paes, head of investment banking at BTG Pactual, who says DCM
fees are the same, and M&A fees are stable but still
attractive.

BTG led the overall league table for Latin America through
August 17, generating $112 million from DCM, ECM, M&A and
loans, or 10.9% of the total pool. The bank was also at the top
of the M&A table, with $74 million, as well as the ECM
table. In ECM, fees have been affected by a greater number of
banks per transaction, as well as many deals not resulting in
full fees due to lower-than-expected pricing.

Domestic markets also help. "DCM and M&A markets
continue to be much better than last year due to the fees from
local markets, which are very strong and always open," Paes
says.

Equity and debt issuance and M&A activity – and
their accompanying revenues – will continue to be
dictated by global economic conditions and, in particular, by
news from the US and Europe.

While Brazil still accounts for most of the
region’s investment banking business, bankers say
the need now is to push for work in growing markets,in
particular Peru, Chile, Colombia and Mexico.

"The revenue base is more affected by Brazil," says Javier
Vargas, co-head of investment banking for Latin America at
Credit Suisse. "LatAm ex-Brazilis probably flat, but given the
size of Brazil, the overall level is down. Investors are a bit
more careful about Brazil these days," he says. "You have seen
different trends for oil and gas and commodity producers.
People are looking elsewhere. The overall trend we see is
greater concern on Brazil."

Debt driver

A weaker economic outlook for the region’s
largest market is a big concern, which has so far only
distorted the outlook for equity fees.

Debt capital markets have driven a sizeable piece of revenue
for the sector – totaling $328 million for the year up
to August 17, compared with $335 million from the same period a
year before. Volumes of business continue to be slightly
stronger than last year. Bankers report mostly stable fees for
deals, already at low 25–40bp levels.

Forecasts for the rest of the year suggest business volumes
somewhere between the first quarter’s DCM
explosion and the second quarter’s slowed volumes.
"I expect high-yield activity to increase in the second half,"
says

Roberto D’Avola, head of LatAm DCM at JPMorgan,
noting such sales accounted for about 22% of the volume so far
this year. JPMorgan is in a three-way tie with Citi and HSBC at
the top of the DCM fee tables, with $33 million.
D’Avola reckons that additional economic stability
should boost issuance and high-yield bonds will come to the
fore. "High yield has a lot of possibilities. Investors will
want to get into these names, but they must be names that are
showing an improvement in their credit profile," he says. In
particular, July transactions from Peru’s Coazucar
and Mexico’s ICA showed encouraging signs of
demand for double-B credits.

As long as the news from Europe and the US does not worsen,
bankers expect more to come.

The market, of course, is always open for top-quality
issuers – as América Móvil showed in
August, raising $1.92 billion in the sterling and dollar
markets.

High-yield issuers are poised to pop up across the region,
D’Avola says. The key will be companies with
growth that comes along with good cash generation. He notes
additional crossover investment and more participation from
LatAm-based investors.

"These are high-growth companies, and their markets are very
underpenetrated," says Eduardo Cruz, head of banking for Latin
America at Citi. "They don’t get the benefit of
real leverage."

High-yield bonds could become another alternative for more
leveraged acquisition finance in the region, says Cruz, with
higher levels of equity being deployed than in other parts of
the world, and with LatAm LBOs tending to be at least 50%
equity financing, and most of the remainder coming from the
bank market. There is room on balance sheets in the region to
reduce this, while taking advantage of investors’
demand for high-yield debt.

The M&A puzzle

M&A volume is set to continue at a healthy pace, and
overall income is up from last year, as is volume, mostly
thanks to a $20 billion deal for GrupoModelo. In June, the
families controlling the Mexican brewer were finally persuaded
to part with their final 50% holding by AB InBev’s
higher-than-expected multiple. The result shook up the league
table, though less so the fee standings, where BTG Pactual
still leads. The $382 million of transaction income so far this
year compares to $356 million for the same period. Fee trends
are largely the same, bankers say.

Several trends may drive volume through the rest of the
year. Bankers say the market segment has barely scratched the
surface of European divestures in Latin America, and there
could be many more to follow.

That said, there have also been some interesting additions
– ranging from Spanish toll road operator Abertis to
Dutch vitamin producer Royal DSM – by Europeans that
can still afford to buy. They join interested Asian and US
buyers in what is still a very strong intra-regional M&A
trend that could grow.

"What we’ve seen over the last few years
continues to be valid – Brazilians consolidating the
local markets, and foreign players moving into Latin America as
a whole," says Jean-Marc Etlin, head of investment banking at
Itaú.

Private equity activity in the region is a third, he says.
The larger and cash-rich entities in Latin America looking
outside the region is another, smaller trend.

After years of threatening, América Móvil
became one such acquirer, upping its stake in Netherlands-based
Royal KPN from 8.7% to 28% at a cost of around $3 billion. A
week before that it had agreed to pay around $1 billion for a
21% stake in Telekom Austria, bringing its ownership to 23%.
Cheap exposure to eastern European countries will be a lever to
further customer business for América Móvil. It
will use its expertise in emerging markets telecommunications
in countries to continue to grow regardless of the troubles in
western Europe.

"Buying in Europe is not as easy as people think," says
Gerardo Mato, CEO of HSBC global banking, Americas. "It is
easier for Europeans to buy in Latin America. If you are cash
rich, you are trying to buy companies at very acceptable
multiples, and trying to grow it from there. We are seeing
Latin Americans interested in buying European assets, and what
we are seeing is also a lot of Europeans reassessing whether to
sell at current multiples."

Consolidation in Brazil in several fragmented industries
should also be a strong source of future business. Bankers are
concerned, however, about regulatory rule changes that would
lengthen the approval process for deals.

This could mean a delay in booking fees, as regulations are
brought more in line with other parts of the world. In the last
week of May, no fewer than 15 transactions involving Brazilians
were announced, to slide in before the Conselho Administrativo
de Defesa Econômica (CADE) put its rule changes into
effect. CADE has streamlined the process in that deals are
approved before they close, rather than requesting adjustments
or asset sales after the deal has gone through.

This situation – occurring notably in transactions
such as Brasil Foods – is now avoided, but the
downside is that deals take much longer, with fees booked at
the close.

"For the Brazilian activity there are the new CADE
requirements which create uncertainty on how long it will take
to approve mergers," Etlin says. "That could create a greater
time lag for fee collection."

Additionally, if global conditions fail to help equity
issuers, business will continue to be pushed to the M&A
markets as companies tap private sources of capital. If they
can advise clients either way, most bankers say it
doesn’t matter where the fees come from, though
some note a tendency for fewer banks on a typical M&A
transaction, thus giving a greater share of spoils than on an
equity deal.

Equities, the poor performer

Equity transactions are the only area to show a big drop off
in fees and volume. The volume of transactions in 2012 has
largely been disastrous again after a rough 2011, especially in
Brazil, and in IPOs. The fee pool reflects the low amounts of
business done so far this year. Revenue so far this year stands
at $236 million, down from $541 million in the corresponding
period in 2011.

The solution to the problem remains the same –
getting wary international investors to participate, especially
in Brazil and pricing deals at the right prices. At present
there is a valuation gap between issuers (and their bankers)
and the buy-side. Investors simply haven’t made
money on deals,especially IPOs.

"I expect high-yield activity to increase a bit in
the second half"
Roberto D’Avola, JPMorgan

BTG Pactual’s nearly $2 billion IPO appeared to
open the space in April, but few could follow. Although the
deal priced in the upper part of its range and there was heavy
demand, it later traded down, along with the Bovespa. The same
is true of a follow-on from Brazil’s Taesa, with
investors drawn in from the issuer’s juicy
dividend returns.

"Equity capital market conditions remain challenging," says
Daniel Darahem, head of LatAm ECM at JPMorgan, who notes that
by the end of July, total issuance in Latin America had dropped
roughly 45% year-on-year. "Despite this decrease, if market
conditions allow it, we expect a strong pipeline of
multi-billion transactions for the second half."

Bankers say what’s needed is an oversubscribed
deal that goes on to trade well, ideally helped by a more
cooperative global environment. Santander Mexico’s
IPO may be one such candidate. The Spanish bank’s
management has

indicated an October pricing for the deal which could raise
as much as $4 billion.

The struggles of its Spanish parent have resulted in a
carve-out of one of Santander’s most liquid and
attractive assets. Bankers and their clients hope this will add
fuel to the pent-up demand caused by investors’
more bullish outlook on Mexico’s economic
prospects. "It is a very competitive market, where being an
underwriter on key deals is essential for long-term stability,"
Darahem says.

Bankers say there are several – perhaps up to 15
– billion dollar-plus deals in the pipeline. If the
markets were to open, some should see the light of day.
However, the window is tight, with only September and October
open for issuers using their second-quarter numbers.

Local demand is also key to completing deals in markets
outside of Brazil. Clearly, small deals in places such as Chile
don’t seek international investors and price
without them. But several large deals this year, including
Chile’s Inversiones La Construcción and
Bancolombia, have relied on local support. In the case of a
July follow-on from Chile’s Cencosud, local demand
saved the supermarket operator from an even deeper discount
than the 7% it ended up paying.

Ideally, this trend won’t continue and
international appetite will return to stronger levels. But
bankers hope local demand will push more issuers from the
ex-Brazil markets.

"In Peru there isn’t a single stock to play the
consumer sector – it just doesn’t exist,"
says Alberto Pandolfi, head of LatAm M&A at Citi. "There
will have to be companies taking advantage of this to finance
themselves. There is going to be a huge appetite for this, and
in Colombia too."

An improved picture for equity markets would do the most to
boost fees. But this is only likely to happen in the event of a
global economic recovery – a scenario that remains
impossible to predict.

"It’s been the most challenging year
we’ve had in five years, particularly for
Brazilian ECM," Etlin says. "But it has been partly offset by
what could be a record year in DCM." LF

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